October, 2006

Cover & Feature Stories

Birth Of The New Retail Environment

It is really the end of the world. And if we don’t get that, we won’t make the right decisions. No, I’m not referring to North Korea’s recent claim to have set off a nuclear device, nor am I referring to the prospect that Iran will soon have nuclear weapons.

I’m talking about the produce industry and referring to a series of small changes, each one of which in and of itself might be unremarkable, many of which you’ve seen written about before in the pages of Produce Business. Now, however, a confluence of these small trends is coming together in such a way that they represent the final curtain call of the post-war model in the produce trade and the birth of a brave new world in produce — a world in which the old rules fall by the wayside and make way for new structures, institutions and ways of doing business.

Let us look at the world that is coming to an end and the new world awakening:

The End of Procurement

OLD WORLD: Value derived by hard bargaining

NEW WORLD: Value derived from supply chain integration and alliance creation

MIND SHIFT: Keeping prices paid low isn’t as important as keeping costs down.

In the end, retailers aren’t going to order anything. All produce items will be shipped on a continuous-replenishment basis.

Many a workshop has been given and many an article has been written about the shift from a transactional procurement model where the buyer tries to buy everyday at the lowest price to one built on relationships, “marketing partnerships,” etc.

This is often a necessity as the large scale of today’s retail organizations would make buying everything “on the market” difficult or impossible. And, obviously, steady procurement from marketing partners can drive costs out of the system as retailers don’t require the same staff of skilled buyers and producers can use the assurance of steady orders to manage costs effectively.

But what is not commonly understood is that a system driven by metrics, rather than personal relationships, builds billions of dollars in extra value. Here is the model:

  • One Commodity
  • One Vendor
  • Year-Round
  • Forever

A big chain can have multiple vendors in different places for the same item, but the crucial part of this model is the word “forever.” As long as a vendor meets pre-defined metrics, that vendor cannot be “fired.” What this does is allow vendors to realize the capitalized value of perpetual supply agreements.

In other words, if a retailer buys unpredictably from various vendors, none of those vendors would be successful at selling their companies at a high multiple or at securing a loan based on past cash flow — because that business stream could evaporate at any time. If a vendor puts its company up for sale and a buyer knows that as long as the vendor performs, the new buyer will keep the business, and the value of that vendor zooms.

The retailer can’t directly keep this “added value” because the retailer’s valuation doesn’t go down because of vendor agreements that are contingent on good performance. So the retailer benefits by allowing the vendor to capture this capitalized value and by negotiating to get a piece of it back via expecting vendors to work closer, getting extra services, etc.

What it mostly does is make vendors willing to lose money on occasion to retain the contract. And here is the crux: One commodity, one vendor, year-round, forever means retailers will increasingly move away from their infatuation with working directly with farmers.

Procurement is a highly complex business with a need to access product from many growing areas and a need to be flexible to get the right product when and where it is needed.

Farmers that are anything but the largest multi-farm agribusinesses are completely inflexible. What retailers want is vendors that grow product, buy it on the tree or in the field, represent other growers, buy on the market, import and, together, keep the flexibility so the chain is never out of stock.

Retailers want vendors that, when the hurricane hits, are on the horn buying pole beans in North Africa and seamlessly keeping the chain supplied. If you are really buying from a farmer in South Carolina and the hurricane hits, the retailer is officially out of product.

The key is to switch the focus from inputs — is this a farmer so I can drive out costs — to outputs — does this vendor meet my metrics, including cost competitiveness.

Of course, metric-driven decisions don’t just benefit vendors. By disciplining the decision-making process as retail, it leads to better decisions at retail.

OLD WORLD: Value derived by owning needed inventory and tools of distribution

NEW WORLD: Value derived from freeing up capital and allowing specialists to take over

MIND SHIFT: Owning everything isn’t a sign of wealth; it’s just a drag on capital returns and a distraction from core competency.

The End of Inventory

Just recently, Cincinnati, OH-based Kroger sold its distribution center in Louisville, KY, to a company that will both own and operate it for Kroger. The one screaming: the union.

Captive distribution centers tend to become repositories for excess costs over time. For labor, the very fact that they are captive means that labor doesn’t have to compete to keep the business. The sunk capital costs usually assure that the chain will continue to use the facility and thus reduce the incentive for workers to moderate wage demands.

The company Kroger sold its Kentucky DC to already operates Kroger distribution centers in Indianapolis and Cincinnati. Other companies, such as Montvale, NJ-based A&P, decided to go with a large service wholesaler, C &S Wholesale Grocers, Inc., based in Hatfield, MA, and outsource not merely ownership and operation of the building but the whole function.

In any case, the ownership of all those bricks and mortar, once perceived as great assets, is increasingly seen as a liability.

Funny enough, not only don’t retailers need to own these DCs but they also don’t need to own anything in them either. In the future, retailers are unlikely to want to own any inventory not actually in the stores.

Right now retailers and suppliers have a divergence of interests — retailers would like to minimize inventory but vendors would like to sell. By having vendors own the inventory, no matter whose warehouse it is in, new incentives are created to minimize inventory and thus drive costs from the system.

The costs will be driven out from the system because one of the metrics that vendors are evaluated on is keeping out-of-stocks to an acceptable level, and violating the metrics could cause a vendor to lose the contract. There is no danger of vendors increasing out-of-stocks to minimize their own inventory costs.

OLD WORLD: Value created by selling all the ingredients to make meals

NEW WORLD: Value created by selling the meals the customer will value

MIND SHIFT: We can add value through value judgments.

The End of Cooking

With the lives of consumers changing so that cooking is not an everyday activity, the sale of ingredients to make meals is less important. Concurrently, the ability to sell meals grows in importance.

This is where traditional departmental lines get blurry since many of these items could be sold in deli as well as produce. Part of the answer is to look to sell solutions to particular issues in the lives of consumers. These can be health-related issues — and Los Angeles, CA-based POM Wonderful’s example of funding medical research is the beginning, not the end of this trend.

These solutions also can be lifestyle issues to which we give a solution such as a fresh-cut salad kit that is perfect for an office fridge. When we market something, increasingly we need to have a concrete notion of the role this item can serve in consumers’ lives. This is a new idea for both produce and retail.

Indeed, the drive to sell meals, not ingredients, has two main obstacles: first, people like to eat protein, and produce is typically a sideshow or ingredient. The first tentative ways of addressing this are things that are done in a small way now — such as adding protein to salads. Inevitably, though, if produce is to have a major role in selling meals, the retail environment will have to become more comfortable with the idea of produce selling items that are protein-based and more diverse.

There have been mostly failed experiments in these arenas: soups and pastas sold in produce, for example. But that was just a consequence of being out on the bleeding edge, before retailers came to understand these are not throwaway lines. In the future, they will be the core products of the department, if the department exists at all in a segregated form.

The second obstacle to successfully selling meals, not ingredients, is that retailers have to adopt a foodservice mentality. Restaurants, by their very nature, make choices about what to put on menus. They make substantive value judgments that the salmon today is better than the grouper, so we’ll make that our special of the day. That asparagus may be nice, but our clientele prefers corn on the cob.

This is very different from a retail mentality of “let’s put it out and see how it sells.” It also creates the opportunity to add value through intellectual firepower. There may be 10 types of potatoes to sell, but there are 10,000 types of prepared potato products — increasingly people will select where to buy because it sells the truffle-oil-laced mashed potatoes with sliced porcini mushrooms on top that they enjoy, and another store does not.

Yet most produce departments have no one qualified to make these judgments, nor any mechanism for making them. Most have no track record of bringing consumer information to vendors and requesting specific product development to meet this perceived need.

It means that the entire staffing and organization of the produce department at retail will have to be reexamined in search of providing the decision-making prowess that will add value in the future.

OLD WORLD: Value created by efficient use of shelf-space to sell high-volume items

NEW WORLD: Value created by segmenting the market

MIND SHIFT: There is no “typical customer” anymore; we are large and we contain multitudes.

The End of Simple

Once upon a time, a retailer might sell a Florida gas-green tomato and be meeting market expectations for tomatoes. Even today, that is rarely true. Tomorrow, the option becoming increasingly clear is between segmenting retail concepts and segmenting consumers with a store.

In other words, you can offer a limited assortment if you have segmented your retail concept to appeal to highly specific clientele, as Publix, Lakeland, FL, is doing with its new Sabor or GreenWise formats, but, in general, consumers might expect the following versions of each item:

  • Organic
  • Fair Trade
  • Locally Grown
  • Greenhouse Grown
  • Upscale Variant
  • Kid’s Version
  • Single Serve Size
  • Family Packs

The focus on the produce trade thus shifts from a commodity-driven industry, accustomed to mass markets, to a highly segmented industry with many more products.

The complexity of the department increases exponentially with the multiplication of product: Training, marketing, procurement, management and more become much more difficult.

OLD WORLD: Value created by selling undifferentiated product at low cost

NEW WORLD: Value created by having identifiable brands you can market against

MIND SHIFT: The leverage for business growth is marketing.

The End of No-Name Produce

One of the requirements for vendors under vendor-managed or co-managed replenishment systems is the requirement that vendors, each year, put together a business plan detailing how they intend to drive the business to achieve acceptable rates of business growth.

Improvements in merchandising can carry this effort for a while. but if the vendors are to satisfy retailer’s demands for growth in each line, the vendors quickly will find a need to do the kinds of marketing and promotion that requires a brand to promote.

This really is a sea change in terms of the kinds of competency vendors will be required to exhibit. Product knowledge and facility in procurement will be only half the deal. Facility with marketing will be crucial.

In the end, all product will be branded to facilitate this marketing — with the exception of the unbranded produce, which will be marketed as true farm-fresh product.

Major national brands capable of doing true branded promotion, such as the Dole Bananimals promotions, will see a resurgence.

In addition, companies without their own brands will secure brands. C.H. Robinson, Minneapolis, MN, has been quietly doing this for years, acquiring such brands as Welch’s for grapes, Tropicana for citrus, Mott’s for apples and Newman’s Own for organic produce.

Each brand does double duty for a company such as C.H. Robinson. First, the brand is a profit-center churning out a steady, reliable stream of income in the form of royalty fees on each carton. Second, when C.H. Robinson sits down with a client to do a business review, it can put together an intelligent marketing plan, driven by the brands. It lets CHR add value to a relationship with a retailer that an unbranded company has difficulty matching.

The boom in cartoon characters for kids is driven, on the produce side, by this thirst for a tool to market. Mid-level companies with good fruit and vegetables, but no marketing heft, now can build a program around Mickey Mouse. It transforms in the eye of a retailer the value of a partnership with a vendor if the vendor brings access to these powerful brands.

Private label will boom in all this. Trader Joe’s and Costco’s Kirkland brand are two models. The new Tesco Fresh & Easy will be driven by private label. Some retailers will want to be 100 percent private label because they want the value of the promotion to accrue exclusively to their operations; others will do private label because the promotional need is universal.

OLD WORLD: Consumers get almost all their food at the supermarket

NEW WORLD: Consumers can get everythingin multiple places

MIND SHIFT: It takes many retail concepts to satisfy both consumers in general and any individual consumer.

The End of the Supermarket

In the 1960s or 1970s, if a competitor to a supermarket was going to open, it meant one thing: Another supermarket was going to open.

  • Today it could mean a lot of other things. Retail concepts that take business from supermarkets include:
  • Warehouse clubs
  • Super centers
  • Specialty supermarkets
  • Convenience stores
  • Internet delivery/pick-up
  • Prepared-food store
  • Meal prep stores (meal assembly centers or MACs)

The supermarket has reached the stage where there is a real question as to whether conventional supermarkets have a viable long-term business model.

The rapid growth of super centers and club stores has made the grocery business cutthroat on price. The rapid expansion of food selection in drug stores and other outlets has made many places more convenient than supermarkets. The rapid growth of foodservice outlets has reduced the percentage of food needs that all retailers can meet.

The response to the competition has been to urge a transformation of the supermarket. Let the supermarket become the anti-Wal-Mart and emphasize perishables, organic, high service. Grocery departments would shrink; delis would blossom.

It was a problematic approach to begin with. Not so much a plan for competition with Wal-Mart, Bentonville, AR, as avoiding competition with Wal-Mart by focusing on a more upscale clientele.

Now, though, with Tesco Fresh & Easy, whose U.S. headquarters is in El Segundo, CA, preparing to launch a new concept based on its Express stores elsewhere in the world, the stakes are raised. These stores are heavy to prepared foods and perishables.

So if Wal-Mart and warehouse clubs led supermarkets to reorganize stores to focus on perishables since they can’t be competitive on groceries, well, what will happen if Tesco’s new concept is a success and traditional supermarkets can’t compete effectively on perishables and prepared foods?

Doesn’t leave much for a supermarket to sell, does it?

Re-Birth

In every ending is the seed of a new beginning, and if the old world we once new in this industry is bound for the dustbin of history, the only question is what will the new world look like.

It looks a lot better than the old one.

First — Costs will be reduced since both procurement and distribution will be done far more efficiently as new systems and approaches supersede the old.

Second — The product assortment in our stores will be more relevant to consumers. It will not be focused on cooking, but instead the selection will be driven by eating. The selection will not be the dictates of a store buyer — this tomato or no tomato — but will either be a carefully tailored selection to meet demographic and psychographic profiles as niche retailing concepts or be a plethora of interesting products to appeal to those who care about the farm workers in Uruguay and others who care about open space in Pennsylvania.

Third — Because of the rise of branding, including private label, the vagaries of product will be reduced. Branded consistency will be the rule, not the exception

Fourth — Food buying options for consumers will be both more interesting and more diverse. There are not only different demographics, but within each demographic there are also many lifestyles. And each individual, whatever his or her demographic and lifestyle, goes through many life stages. All consumers have life events that take them into different roles.

An awareness of this will supplant the simple practices of breaking stores down by demography as A, B, C or D stores. The key is that people won’t be segmented the way retailers would prefer. The same person can buy from Wal-Mart and Whole Foods (Aurora, CO), from Costco (Issaquah, WA) and WaWa (Wawa, PA) — as the industry responds, the available concepts are exciting to behold.

What kinds of organizations will be the winners in this brave new world? Those that can break the bonds of legacy and develop new procurement models, new distribution models, new store concepts.

Retailers that win will be those that emphasize supplier development and vendor-managed replenishment and that share data and information. Put another way, the successful retailers of tomorrow are those that best get suppliers to help them. It is hard to be a superstar all by yourself.

Wal-Mart likes to think of itself as the buying agent for the consumer, and it is fair to say that most retailers mess up because they start thinking about something other than the customer.

Unfortunately, Wal-Mart’s claim has been turned into a cartoon in which it is assumed that the only concern of consumers is low price.

What is required is that every time a decision has to be made, the retail executives ask themselves whether if a consumer understood all the dynamics; is this what they would want us to do? Maybe we should give out bracelets to retail executives: What would the consumer do?

This means that words such as “margin enhancers” have to be banished from the vocabulary, as the goal is fair dealing on each and every item.

It is easy to over-invest — would consumers urge that showy tortilla-making machine if they understood what they were paying for it?

Just as retailers will only win if they work effectively with their suppliers, it will also be hard for a retailer to win if that retailer doesn’t work effectively with the whole industry to advocate supply system change.

Basically, there are only two options. Very large retailers can compel suppliers to do their bidding. But nobody likes being treated like a serf, so giving orders left and right is a recipe for a supplier base that hates you — not a recipe for success.

Smaller and mid-size retailers often can’t get what they want done at all and, if they can, the cost of differentiating from industry norms can be expensive.

So the only solution is being involved industry-wide with associations, task forces and committees. The idea is to build consensus behind a progressive vision...then large retailers can ask their vendors to support this industry-driven vision and smaller retailers can ride the wave of industry standardization.

There is something lost in this vision of the future. The product itself, diced, sliced, mashed and cooked in a thousand ways, becomes less important. Passion for produce feels somehow secondary to facility with EDI systems and expertise in supplier development. There is something dry, something technocratic about it all.

But this model, consumer-driven — enabled by new technology and created by new ways of thinking — is also an extraordinary achievement. What this will deliver the world is more product, more perfectly tailored to each person, more fun, more safe and more delicious than ever before.

It is extraordinary that we have a chance to be a part of this transition.  pb